US Bond Market Week in Review: Is the Economy Weaker Than the Fed Thinks?

This week, in her statutorily mandated Congressional testimony, Janet Yellen gave a fairly upbeat assessment of the economy:

Meanwhile, the economy appears to have grown at a moderate pace, on average, so far this year. Although inflation-adjusted gross domestic product is currently estimated to have increased at an annual rate of only 1-1/2 percent in the first quarter, more-recent indicators suggest that growth rebounded in the second quarter. In particular, growth in household spending, which was weak earlier in the year, has picked up in recent months and continues to be supported by job gains, rising household wealth, and favorable consumer sentiment. In addition, business fixed investment has turned up this year after having been soft last year. And a strengthening in economic growth abroad has provided important support for U.S. manufacturing production and exports. The housing market has continued to recover gradually, aided by the ongoing improvement in the labor market and mortgage rates that, although up somewhat from a year ago, remain at relatively low levels.

However, over the last 6-9 months, a number of economic soft spots have emerged, starting with auto sales:

Although they are still at strong levels, they have softened a bit. And there are several news stories reporting dealers are increasing incentives to move inventory.

Top line PCE growth (top table) has been weak in 3 of the last 5 months. Durable goods spending has declined in 4 of the last 7 months. Real retail sales (bottom chart) have declined in 5 of the last 13 months and grown weakly in an additional two.

Industrial production is a bit weaker than the topline figure suggests:

Over the last 5 years, mining has been the primary reason for growth in industrial production.

Wage growth remains weak:

After 8 years of expansion, Y/Y wage growth is still below the lowest level seen in the last expansion – which itself was modest.

And there’s a remarkable lack of inflation:

CPI – both total and core – has been declining for the last 6 months. The Fed attributes this to transitory factors. However, the fact this has been moving lower for 6 months indicates there’s probably something else going on.

Consumer spending accounts for 70% of US economic growth. While US consumers are spending, they’ve pulled back a bit on durable goods purchases – specifically, autos. There has also been a drop in department store shopping. Growth in industrial production is heavily dependent on oil extraction. We’re still not seeing meaningful wage increases, despite very low unemployment and 9 years of economic growth. And despite readings over the Fed’s 2% level, CPI is now dipping below 2%. While no expansion is perfect, we’re now seeing the breadth of weaker data expand.